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THE CURRENCY
The Hong Kong dollar is a freely convertible currency and there are no foreign exchange restrictions or controls on the dealing, import and export of local currency for both residents and non-residents. Also, there is no withholding tax for Hong Kong dollar deposits. Hong Kong dollar banknotes are issued by three authorized commercial banks: The Hongkong and Shanghai Banking Corporation Limited (more usually known as HongkongBank), Standard Chartered Bank and the Bank of China. Coins are issued by the Hong Kong Government. Under the present system, the value of Hong Kong dollar notes is linked to the US dollar at the fixed rate of HK$7.80 to US$1. Note-issuing banks are required to place the equivalent amount of US dollars with the Exchange Fund (the holder of fiscal and monetary reserves) for backing the banknotes issued. This rate was set on October 17 1983 for only those banknote transactions between the Exchange Fund and the note-issuing banks. Foreign exchange transactions on the Hong Kong dollar among banks and the non-bank public take place at a floating rate, which is determined by market forces.
Before the linked-rate system was adopted, the currency had been on a floating basis since late 1974. The monetary authority of Hong Kong at that time had no effective control over money supply; market conditions determined both the levels of money supply and the exchange rate. The floating-rate system ended in 1983 when a crisis of confidence over Hong Kong's political future broke out, prompting the Hong Kong dollar into a free-fall. By establishing the linked rate, the government was attempting to restore the stability of the Hong Kong dollar, holding back the vicious circle of the fall. A rate of HK$7.80 to US$1 was chosen based on the monetary and trading conditions at the time.
MARKET OPERATIONS
Under the linked-rate system, note-issuing banks are required to deposit US dollars with the Exchange Fund, at the fixed rate of HK$7.80 to US$1, for a certificate of indebtedness to cover the issue of Hong Kong dollar notes. Any change in the amount of banknotes circulated is matched by the equivalent US dollar payment to the Exchange Fund. Banknote transactions among banks are all settled in the Hong Kong dollar value. The...